FCX

Business Context and Reporting Period

Company: Freeport-McMoRan Copper & Gold Inc. (FCX)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2002
Primary Operations: One of the world's largest copper and gold mining companies, primarily operating the Grasberg mine in Papua, Indonesia, through its subsidiary PT Freeport Indonesia (90.64% owned). The company also operates a smelter in Spain (Atlantic Copper) and holds a 25% interest in an Indonesian smelter (PT Smelting).
Key Joint Venture: Rio Tinto plc holds a 40% interest in certain assets and production from Block A (Grasberg) and exploration projects in Papua.

Key Financial Metrics

Production (2002):

• Copper: 1,524,200,000 pounds (Record high, +9% vs. 2001).
• Gold: 2,296,800 ounces (-13% vs. 2001 due to lower grades).
• Mill Throughput: 235,600 metric tons per day (-1% vs. 2001).

• Average Net Cash Production Cost (Copper): $0.08 per pound (+14% vs. 2001, driven by lower gold credits).
• 2001 Cost: $0.07 per pound (Record low).

• Net Income: $164.7 million (2002) vs. $113.0 million (2001).
• Income from Investment in PT Freeport Indonesia: $343.7 million (2002) vs. $255.2 million (2001).
• Interest Expense (Net): $104.8 million (2002) vs. $77.5 million (2001).
• Ratio of Earnings to Fixed Charges: 3.4x (2002) vs. 2.9x (2001).

• Long-term Debt (Registrant): $1.36 billion (2002) vs. $1.45 billion (2001).
• Cash and Restricted Investments (Registrant): $97.3 million (2002) vs. $142.5 million (2001).
• Pro Forma Indebtedness: Approximately $2.8 billion (reflecting early 2003 debt issuances).

• Copper: 35.7 billion pounds.
• Gold: 44.0 million ounces.
• Silver: 100.5 million ounces.

Material Changes vs. Prior Period

• Production Volume: Copper production reached a record 1.5 billion pounds, driven by higher average ore grades. Gold production declined 13% due to significantly lower average gold grades.
• Cost Structure: Net cash production costs per pound of copper increased to $0.08 from $0.07, primarily due to reduced credits from gold sales.
• Ownership Structure: In February 2002 (accounted for as of Dec 31, 2001), FCX repaid a $253.4 million bank loan guaranteed for PT Indocopper Investama (Nusamba), increasing its ownership in PT Freeport Indonesia to 90.64% and Eastern Minerals to 100%.
• Dividend Policy: No cash dividends were paid in 2001 or 2002. A new policy was authorized in February 2003 for an annual dividend of $0.36 per share.
• Auditor Change: FCX replaced Arthur Andersen LLP with Ernst & Young LLP in July 2002 following Andersen's conviction for obstruction of justice.

Guidance, Outlook, Risks, and Contingencies

Outlook and Guidance:

• 2003 Production: Estimated sales of 1.4 billion pounds of copper and 2.6 million ounces of gold. This reflects expectations of lower copper ore grades but higher gold ore grades.
• Capital Expenditures: Projected aggregate capital expenditures to reach full production for undeveloped ore bodies total $2.05 billion (shared with Rio Tinto).
• Environmental Costs: Expected to incur approximately $9 million in environmental capital expenditures and $37 million in other environmental costs in 2003.

• Management emphasizes FCX's position as the lowest-cost copper producer globally.
• Exploration in 2003 will focus on Block A targets due to low copper prices and suspended activities in other areas.

• Political and Security Risks: Operations in Papua face risks from separatist movements, civil unrest, and terrorism (e.g., Bali bombing, August 2002 ambush). The company relies on the Indonesian government for security, providing supplemental support ($5.6 million in 2002).
• Contract of Work: The primary Contract of Work expires in 2021. Extensions are subject to government approval. Disputes could lead to termination or arbitration.
• Environmental Liabilities: Significant challenges regarding tailings disposal and acid rock drainage. Estimated aggregate reclamation and closure obligations are $120 million (undiscounted) with a fair value of $30 million.
• Commodity Prices: Profitability is highly sensitive to fluctuations in copper and gold prices. Prices in 2002 ranged from 64-77 cents/lb for copper and $278-$349/oz for gold.
• Debt Service: Substantial indebtedness requires significant cash flow. Covenants restrict dividends, stock repurchases, and additional borrowing.

Investor Verification Checklist

• Reserve Estimates: Verify the assumptions used for the 35.7 billion pounds of copper and 44.0 million ounces of gold reserves, particularly regarding the $0.85/lb copper and $270/oz gold price assumptions.
• Contract of Work Status: Monitor the status of the Indonesian government's fact-finding team regarding compliance with the Contract of Work and the likelihood of the 2021 extension.
• Security Environment: Assess the ongoing security situation in Papua and the stability of the relationship with the Indonesian government and military.
• Debt Refinancing: Review the terms of the new debt issuances in early 2003 ($500M 10 1/8% Notes and $575M 7% Convertible Notes) and their impact on interest coverage ratios.
• Environmental Compliance: Track the results of the 2002 independent environmental audit and any regulatory changes regarding tailings management.
• Auditor Transition: Confirm the completeness of the transition from Arthur Andersen to Ernst & Young and the lack of disagreements on accounting principles.